Dividend stocks are back in favor since the dividend tax rate has come down and more investors seek retirement income. Dividend yield is calculated by dividing the dividend by the stock price. High dividend stocks yielding greater than 6% are particularly enticing in today's investing environment, given that the S&P 500 yields only about 2% and treasury bonds yields are at multi-decade lows, yielding about the same as or even less than the S&P 500.
Dividend stock investing is not without pitfalls, however. Unlike bond interests, which are guaranteed by contract, dividend income is not guaranteed. A high dividend may not be sustainable. Stockholders are junior to bondholders; therefore, interest payments must be made before any dividends may be paid out.
Another caveat of high yield dividend stocks is that the high dividend yield usually goes to more risky stocks. A high dividend yield may be due to a rapidly falling stock price, rather than raised dividend, and that could be an ominous sign of possible dividend cut in the future.
A third caveat of high yield dividend stocks is that the money paid out in dividend is no longer available for investing back into the companies' operations to provide for future growth and expansion.
Because of these caveats, screening for high yield dividend stocks is not enough; investing simply in the highest yielding stocks may in fact be detrimental to an investor's total return. Investors seeking high yield dividend stocks are well advised to look for the following characteristics as well:
1. High interest coverage. Interest coverage, also known as times interest earned, is the ratio of earnings before interest and taxes (EBIT) to interest expense. The higher this ratio, the more likely a company is able to cover its interest expense from earnings, and more likely dividends will be sustainable. To be conservative, I will screen for interest coverage at least five.
2. Low beta. Beta is the volatility of the stock compared to that of the general market. Higher beta implies higher risk, and lower beta lower risk. It is ideal to look for lower risk stocks when screening for high yield, because a high dividend yield may be due to a rapidly falling stock price, typically indicative of a company in trouble. In this exercise, I will screen for beta less than 1.4.
3. High earnings-per-share (EPS) growth averaged over 10 years. Because high dividend yield takes money away from funding future growth for a company, investors who do not wish to trade a high current yield for low future growth should insist on reasonably high EPS growth for a stock. To be conservative, I will screen for EPS growth at least 4%, averaged over the past 10 years.
For dividend yield, I will consider 6% or greater as high yield, since historically stocks are undervalued when yields exceed 5-6%, and are overvalued when yields fall below 3%.
A screen for these factors gives the following 10 stocks (Table 1):
|Company name||Symbol||Last price||Market cap||P/E ratio||Div yield (%)||Interest coverage||Beta||10y EPS growth rate|
|Annaly Capital Management, Inc.||NLY||16.08||15.60B||8.39||14.15||29.79||0.30||5.85|
|Companhia de Saneamento Basico (ADR)||SBS||55.45||6.32B||9.20||7.82||7.04||1.34||19.07|
|Getty Realty Corp.||GTY||14.00||467.52M||10.27||7.15||10.86||0.96||14.36|
|KT Corporation (ADR)||KT||15.60||8.15B||10.72||7.23||6.41||0.95||8.03|
|Portugal Telecom, SGPS (ADR)||PT||5.63||4.93B||10.39||15.88||5.07||0.70||6.37|
|SK Telecom Co., Ltd. (ADR)||SKM||13.55||9.85B||6.75||7.11||9.73||0.92||7.49|
|Suburban Propane Partners, L.P.||SPH||47.73||1.69B||14.85||7.21||5.23||0.43||4.10|
|Telefonica S.A. (ADR)||TEF||17.09||78.00B||4.90||12.63||6.40||1.00||13.09|
|Terra Nitrogen Company, L.P.||TNH||163.70||3.06B||11.63||8.24||673.00||0.71||22.30|
|YPF SA (ADR)||YPF||35.46||13.95B||10.49||9.79||9.71||0.79||11.72|
Table 1. A recent stock screen (from google.com/finance on Jan 1, 2012) gives 10 stocks that met our criteria (yield>6%, interest coverage>5, beta<1.4, and 10-yr EPS growth>4%).
This portfolio of 10 high yield stocks has an average yield of 9.7%, which is very high, beating the market's yield of 2% by more than 7%. The average P/E is 9.7, which is quite reasonable and significantly lower than that of the market.
This portfolio slightly favors international stocks, which comprise 60% of the portfolio.
By sector, four (KT, PT, SKM, TEF) of these ten stocks are telecommunications stocks. Two (NLY and GTY) are REITs. Two (SPH and YPF) are energy stocks. One is a utility stock and one is a basic materials sector stock. Because of the overweight of the telecommunications sector, this portfolio is not well-diversified, but can form part of a diversified portfolio for investors looking for higher yielding stocks.
Use this information as a starting point for your own due diligence and research methods before determining whether or not to buy or sell a security. While the added screening criteria greatly reduce the risk of dividend cut, there is no guarantee that these stocks will not experience dividend cuts, or that investors will not lose money investing in these stocks. Past performance does not guarantee future returns.
If you do decide to buy any of these high yield stocks: monitor them regularly, ensuring that interest coverage remains adequate, EPS growth rate remains satisfactory, and no significant changes to the fundamentals have occurred that would threaten a dividend cut.
Investors looking for high yielding dividend stocks are well advised to pay attention to interest coverage, beta, and 10-year EPS growth rate, to ensure that a high yield is sustainable, the stock is relatively low risk, and that the high yield is not a trade-off for low growth.
Disclosure: I am long NLY.